ACE Act Proposes Tax Law Changes to Incentivize the Disbursement of Charitable Funds
On June 9, Senators Angus King (I-Maine) and Chuck Grassley (R-Iowa) introduced the bipartisan Accelerating Charitable Efforts (ACE) Act to reform tax laws covering charitable donations, so that philanthropic funds are made available to working charities within a reasonable time.
Working charities often are chronically short of funding to provide needed services to the general public. Especially during the pandemic, many organizations have been struggling for survival. The ACE Act is intended to address this problem and accelerate getting charitable dollars into the hands of working charities.
There is currently more than $1 trillion held by nonactive charities, specifically donor-advised funds (DAFs) and grant-making private foundations (PFs), and the amount continues to increase. For years, Congress and other commentators have highlighted this issue, so the proposed legislation should come as no surprise. According to the legislation’s supporters, current law provides insufficient incentives to ensure this funding is used for its intended purpose — to support operating charities and the communities they serve.
Current law can incentivize the “parking” of charitable funds in a privately controlled charity in numerous ways:
- The DAF/PF structure allows donations of non-cash assets, such as shares in a private company or real estate, with an immediate fair market value charitable tax deduction for the donor.
- DAFs/PFs allow donors to avoid capital gains taxes on low-basis assets.
- Donations are tax deductible when contributed to the DAF/PF, rather than when given to an operating charity.
- Distributions to operating charities can be made at a distant point in the future, without penalty or restriction.
- These funds generate a significant amount of investment management fees for fund managers, so they are incentivized to keep account balances high.
Most opposition to the bill unsurprisingly is coming from organizations that represent high-net-worth donors’ interests in maintaining the tax benefits currently available under the DAF/PF structure. The Council on Foundations posted an initial alert on June 10, stating that the legislation “will not achieve the ends we are all seeking to realize — greater support for nonprofits and communities, now and in the future, as we work together to advance the greater good.” The alert also urged others to take action and send a message to members of Congress to oppose it.
Summary of Proposed Regulations:
The ACE Act proposes the following new rules for DAFs and PFs.
- Qualified DAFs (15-year DAFs): A donor would get an upfront income tax deduction (as under current law), but only if DAF funds are distributed or advisory privileges are released within 15 years of the donation.
- Non-Qualified DAFs (50-year DAFs): A donor would continue to receive capital gains and estate tax benefits upon donation but would not receive an income tax deduction until the donated funds are distributed to a charitable recipient. All funds must be distributed outright to charities no later than 50 years after their donation.
- Qualified Community Foundation DAFs: A donor would be able to hold up to $1 million (subject to annual inflation adjustments) in DAF funds at any community foundation without being subject to the above rules. For amounts over $1 million, a donor still could receive up-front tax benefits if the DAF requires a 5% annual payout or if donations must be distributed within 15 years of contribution.
- Valuation rule: The income tax deduction for complex assets, such as closely held or restricted stock, would be the amount of cash made available in DAF accounts from the sale of the asset (instead of the appraised value, as under current law).
- Penalties for failure to comply: A penalty of 50% of the undistributed amount would be assessed after a six-month grace period to distribute the required amount after year end.
- Public support test consideration: Amounts received by active charities from DAFs would no longer be treated as support received from a publicly supported organization [those described in IRC Section 170(b)(1)(A)]. Rather, the donation would be attributed to the DAF donor. Distributions from a DAF that had no active donor advisory privileges would be excepted.
- Disallowance from qualified distribution:
- Administrative expenses paid to disqualified persons would no longer be eligible for treatment as qualifying charitable distributions.
- Distributions from PFs to DAFs would not be treated as qualifying charitable distributions.
- Net investment income tax exemption:
No tax would be imposed if:
- The PF makes qualifying distributions during a taxable year in an amount that, to keep it simple, is roughly at least 7% of the PF’s noncharitable use assets at the beginning of the year.
- The PF has a duration specified in its governing documents of not more than 25 years and makes no distributions to a disqualified private foundation, which is another PF with the same disqualified person on both PFs.
Failure to comply with the above rules will subject the PF to tax recapture.
This legislation has the potential to significantly change how DAFs and PFs are operated by shortening their lifespan and forcing them to accelerate their grant-making. We will continue to monitor the status of the legislation and any impact on the DAF/PF community.
If you have questions about how the ACE Act could impact your private foundation, reach out to our experts.